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Financial News asks what impact, if any, the decision by Moody's late last week to strip the UK of its triple-A rating will have on the country and investor appetite for its debt.

1) What does history tell us about downgrades of triple-A sovereigns?

It tells us there's no need for any immediate panic. We’ve been here before, most comparably with the US and France. In both cases the implications for national creditworthiness were benign.

The working day after Standard & Poor's downgraded France to AA+ at the start of 2012, the country’s two-year bond yield fell from 0.888% to 0.812% and a month after the downgrade, it had fallen further to 0.695%. Six months later, it had fallen markedly to 0.121%, and a similar pattern played out for its five-year debt.

When S&P downgraded the US in August 2011 two-year sovereign bond yields fell from 0.287% on the day of the downgrade to 0.257% on August 8, the next working day. Six months after the initial downgrade, it had fallen yet further to 0.234%.

While the US had the advantage of the dollar being the world’s reserve currency, France emphatically did not. Some predict marginal selling of Gilts by foreign investors but there is strong domestic support – not least from the Bank of England and UK banks – for the UK sovereign and; as with all sovereigns, it can print its way out of default.

Gary Jenkins at Swordfish Research described losing a triple-A rating as “a bit like mother selling her furs or losing the oil painting from the board room. It’s a status symbol. While important in some ways, it’s less so for a country with its own printing press.”

2) Will any fallout be more political than economic?

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Ratings moves are notoriously lagging indicators and investors say that a downgrade was already fully priced in by the market. David Lloyd, head of institutional portfolio management at M&G, said: “Any issues have not been brought into greater focus as a result of this ratings move which was entirely expected.”

Both the immediate and long-term impact is likely to be political, given that the Chancellor of the Exchequer, George Osborne, staked much political capital on the preservation of the UK’s top rating, but it is impossible to divorce economics from politics in finance.

While describing himself as sanguine about the downgrade itself, Lloyd said that he was “far from sanguine about the issues that prompted it”.
Jon Mawby, senior portfolio manager at GLG Partners, said: “The downgrade is primarily associated with the lack of growth in the UK so we are likely to see more monetary easing”.

This entails an inflationary approach to the way out of the growth problem and this is where the politics collide with the economics as sterling will weaken further, having already been sold off aggressively since the beginning of the year. An inflationary approach will particularly unpalatable as it would hit middle-income earners.

Stuart Richardson, chief investment officer of RMG Wealth, said: “The bank’s tolerance of above-target inflation and the extraordinary policy measures it is taking [such as quantitative easing and the Funding for Lending Scheme] are going to lead to a weaker currency over time."

3) What has to happen for sterling to suffer another downgrade?

Moody’s said when announcing the downgrade that it does not anticipate any further movement in the rating over the next 12 to 18 months. However, the ratings agency added that there were two scenarios under which “downward pressure on the rating could arise”.

First, the ratings agency said that a failure on behalf of the government to stabilise and begin to ease the country’s debt burden during the fiscal consolidation programme could lead to the ratings agency revising the rating downwards. Second, it could downgrade the debt further “in the event of an additional material deterioration in the country's economic prospects or reduced political commitment to fiscal consolidation”.

Downgrades by the other agencies are more likely – Richardson described Moody’s downgrade as a “mark to market” move given that the US and the UK are undergoing similar stresses. Both Fitch and S&P have the UK rated at triple-A with negative outlooks.

But the impact of further reassessment by rating agencies is likely to be limited as the market would probably already have reacted to the reasons behind it.

“We’re all entirely aware of what the agencies are scrutinising,” said Lloyd at M&G. “It’s extremely unlikely that they are going to spot something the markets haven’t or take a materially more negative stance.”

4) Where else can Gilt investors go?

In the unlikely event of anything more than a marginal sell-off there is a small number of alternatives: in the G8 just Germany and Canada enjoy top ratings across the board, though Jenkins warns that the former may not rejoice in a top rating for long: “It might well be worthy of a AAA rating on its own but as shadow guarantor for the rest of Europe, how long can it hang on to the rating?” Moody’s put Germany on negative watch in July last year.

Instead of chasing a dwindling pool of triple-A rated sovereigns, investors may adjust their investment criteria and look at top-rated corporates. However, this would raise questions of liquidity – there are many corporate issuers with triple-A ratings to choose from but the sovereign bond markets remain the most liquid in the world.

5) Do people care what the rating agencies say?

It can depend on the product. Given that the move and the reasons behind it were well-flagged, M&G’s Lloyd said that the downgrade did not cause “an icy blast” to blow through the Gilt market.

The rating agencies’ failings in the structured credit market are well-rehearsed, but their reputation in the sovereign sector is not much better in some quarters.

“The agencies will argue that they started downgrading Greece long ago but they were still in the single-A range two or three weeks ago and the thing’s defaulted twice,” said Jenkins. “You could argue that they’ve been even worse with financial institutions because every one of them would have gone bust if it hadn’t been for government intervention.”

The agencies are still held in relatively high regard in the sphere of non-financial corporate debt, probably, said Jenkins “because there’s a lot more input taken from the pure figures". He added: “It’s not so suggestive and whereas the assets on the balance sheet of a bank have proven to be very difficult to value and measure, assets and liabilities on the standard corporate’s balance sheet are quite straightforward.”